Friday, March 7, 2014

Wrong lesson from Adam Smith's pin factory

We commonly use stories to teach new ideas, but all too often end up taking the wrong lessons from them. My favourite example is the Coase theorem. Economics textbooks describe theorem as saying that it doesn’t matter where you place the liability for pollution, because in a world of zero transaction costs the right to pollute will end up in the hands that value is most. This is the exact opposite of the point Coase made. As Deidre McCloskey wrote,
Economists have gotten the “theorem” wrong; in fact, backwards

Coase’s actual point, the core of a Coasean economics, was to note what happens in the many important cases in which transactions costs cannot be neglected. If the situation does have high transactions costs, then it does matter where the liability for pollution is placed.
I was alerted to another example in Joan Robinson’s long forgotten textbook. In it she dismisses the division of labour as a primary factor in the great surge in productivity of the industrial revolution, noting that this is the wrong lesson to take from Adam Smith’s pin factory story.

First let me recount the relevant part of Smith’s writing where he describes the productivity boon enabled by the division of labour.

To take an example, therefore, from a very trifling manufacture; but one in which the division of labour has been very often taken notice of, the trade of the pin-maker; a workman not educated to this business (which the division of labour has rendered a distinct trade), nor acquainted with the use of the machinery employed in it (to the invention of which the same division of labour has probably given occasion), could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty.  
But in the way in which this business is now carried on, not only the whole work is a peculiar trade, but it is divided into a number of branches, of which the greater part are likewise peculiar trades. One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on, is a peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which, in some manufactories, are all performed by distinct hands, though in others the same man will sometimes perform two or three of them.  
I have seen a small manufactory of this kind where ten men only were employed, and where some of them consequently performed two or three distinct operations. But though they were very poor, and therefore but indifferently accommodated with the necessary machinery, they could, when they exerted themselves, make among them about twelve pounds of pins in a day.  
There are in a pound upwards of four thousand pins of a middling size. Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day. Each person, therefore, making a tenth part of forty-eight thousand pins, might be considered as making four thousand eight hundred pins in a day.  
But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them have made twenty, perhaps not one pin in a day; that is, certainly, not the two hundred and fortieth, perhaps not the four thousand eight hundredth part of what they are at present capable of performing, in consequence of a proper division and combination of their different operations.

This insight has attracted so many followers and is so embedded in economic thinking, that it was quite a shock for me to see it dismissed. Robinson merely states that people can equally divide their own labour across different tasks through time and thus Smith is incorrect in attributing the productivity of the pin factory to the division of labour.

The 18 distinct operations Smith recounts could just as easily be conducted by the same labourer on 18 different days to create the same output per person over an 18 day period as in the case where labour is divided between workers.

I’ll be honest. Dismissing one of the key elements of accepted economic theory in a single sentence is bold. But again, Robinson had a lot to get through in a short book.

So what is the real lesson? To me the lesson of productivity is not about division of labour, but of capital accumulation. 

Smith suggested it was the division of labour that had ‘given occasion’ to the invention of machinery. But this gets causality backwards; it is the new tools and production techniques that allowed both the division of labour and the great increase in efficiency. 

Imagine that each on the 18 separate tasks could be achieved more efficiently with 18 different new tools. Drawing the wire used a particular apparatus, straightening another, and cutting yet another, and so on.

For the individual labourer to be equally efficient as the factories of the time, each labourer would need 18 different tools that each sat idle for 17/18ths of the time. Thus it is the search for returns on the investment in new tools and equipment that allowed for both the observed division of labour and the radical increase in productivity.

You might interject that if 18 labourers joined together they could each buy a single different tool and simply share their own tools on the off days, that they would be equally efficient as a group. But in fact, they would simply be a factory, with the only difference to Smith’s example that workers owned all the capital.

Thus it is capital investment that leads to larger firms, internal coordination via division of labour, and increases in productivity. That is the real lesson of Smith’s pin factory.

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  1. The core point seems to be that one person working for 18 days, with the same capital (and an assumption of zero interest) would be as productive, and, presumably as profitable, as 18 people working for one day. If labor were the only factor, this would indeed be the case. However, rent is also a factor. Either the workman is in a town where the rent is significant, or he is in a remote location where he has the added expense of hauling the pins to market.

    Capital accumulation is important, but rent is also important. If 18 people work at the factory, they each have to generate 1/18 of the rent. If one person works alone, he has to generate the entire rent.

    1. Dam, it fhe one person worked alone then they wouldn't need as much space as the 18. Therefore the rent will be lower. At least this is how it is for the manufacturing business I know.

    2. And a curse upon the idiots who developed the text correction for Android. My sincere apology Dan for it turning your name in to the other.

  2. The idea that one person could operate 18 different steps as efficiently as 18 people, each of whom specializes in a single step, is false. Each of the steps has little quirks and oddities that must be learned in its execution, and a person executing that step repeatedly over time will do better at it than someone who only tries a hand at it once every 18 days. Perhaps you could argue a person could work for a whole month at one step, then work a month at the next step, and so get into the swing of each one more effectively than doing it once per day. But this reveals the other error of this thought. You need more material on hand, and more storage space to keep all of the work in progress. You would need to have 18 months of materials in the shop to do this, while having 18 specialists working together allows you to keep a little more than a day's worth. I'm pretty sure "economy of scale" is real.

    1. But that runs counter to Smith's argument. The idea is that the machinery can be run by workers with little or no skill. Sure, the workers might increase their efficiency somewhat in time, but that would be nothing compared with improving the effectiveness of the relative tools. The workers should be as replaceable as the tools.

    2. That's true, it does run counter to Smith's argument.